Boston Beer Company Inc (SAM) 2008 Q3 法說會逐字稿

Good afternoon. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the 2008, third quarter earnings call for Boston Beer Company. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS). Thank you.

Mr. Jim Cook, Founder and Chairman, you may begin.

(Technical difficulties, no audio) -20 % as compared to the third quarter in 2007. Net revenue increased due to volume and pricing of core products, a decrease in excise tax due to the $3.9 million reserve for additional liability recorded in the third quarter of 2007 and the non-core revenue associated with the production under the Diageo contract. Our core shipment volume for the three months ended September 27th, 2008 net of recall returns, was approximately 501,000 barrels, a 6% increase over the same period in 2007. We believe that whole seller inventory levels at September 27th, 2008 were in line with the prior year's levels. Cost of goods sold increased primarily due to the cost of the Diageo production, the increased costs of raw and packaged materials, increases in volume for core products, the accrual for full-year shortfall fees and the Pennsylvania Brewery startup costs.

Advertising, promotion and selling expenses increased by $1 million during the quarter as compared to the prior year primarily due to increases in freight expenses to wholesalers and salary and benefit costs. General and administrative costs increased by $2.8 million during the quarter as compared to the prior year, driven by the addition of reoccurring plant administrative costs related to the Pennsylvania Brewery, salary and benefit cost and legal cost. The income tax provision for the three months ended September 27, 2008, decreased to $900,000 from $1.7 million for the same period in 2007 as a result of lower pretax income.

The 2008 full-year effective tax rate is expected to be approximately 51% as a result of lower than expected pretax income, primarily due to the recall but with no corresponding reduction in non-deductible expenses. Shipments and orders in hand suggest that gross core shipments through November 2008 appear to be up approximately 12% as compared to the same period in 2007. Net of product returns, core shipments appear to be up approximately 9%. Actual shipments may differ and no inferences should be drawn with respect to shipments in the future periods.

Year-to-date depletions reported to us through September 2008 were up approximately 10% over the same period in 2007, but this number may not be indicative of actual business trends, due to some inconsistent reporting of the recall and the numbers that are available to us. Based on our current assessment, guidance for earnings per diluted share for the full year has been reduced to between $0.60 and $0.80 due to the increased costs which include incremental recall costs and start up costs at the Pennsylvania Brewery, a higher income tax rate and slightly reduced full-year volume projections. Somewhat offset by additional pricing increases in certain markets implemented in October 2008.

Based on our assumptions about the financial impact of the recall, which primarily includes provisions for recall cost and related tax impacts, we currently estimate that 2008 earnings per diluted share excluding the impact of the recall, will be between $1.60 and $1.80. Looking forward to 2009, based on current known information, we see cost increases primarily in packaging costs due to a new glass contract and due to the depreciation and operating cost of our Pennsylvania Brewery. The 2009 cost increases are expected to be between 8% and 11%.

These cost increases will be somewhat offset by price increases currently targeted at 3% and operational efficiency initiatives in 2009, but we anticipate that 2009 gross margin percentage could be down below full year 2008, excluding the impact of the recall on gross margin in 2008. While we continue to experience a healthy pricing environment, there is no guarantee that we will be able to achieve the planned price increases. We will provide 2009 guidance when we present full-year 2008 results. As previously reported, we currently estimate total capital expenditures in 2008 to be between $110 million and $120 million of which $45 million was the balance of the purchase price of the Pennsylvania Brewery, paid in June and $45 million to $55 million relates to the capital expenditures necessary to restart and upgrade the Pennsylvania Brewery.

We are currently evaluating 2009 capital expenditures and based on current information, expect them to be between $25 million and $45 million, most of which relate to continued investments in the Pennsylvania Brewery as we pursue efficiency initiatives. The wide range is indicative of some uncertainty that we will complete all the anticipated projects in 2008 and some of those projects may be completed in 2009. The actual amount spent may be different from these estimates. We expect that our cash and investment balances as of September 27, 2008, of $10.6 million, along with future operating cash flow and our unused line of credit of $50 million, will be sufficient to fund future cash requirements. We will now open up the call for questions.

(OPERATOR INSTRUCTIONS) . Your first question comes from the line of Lindsey

Hey, how are you doing.

Hi, Lindsey.

I was wondering if you could give us some color what you're seeing at the consumer level, anything related to the economic downturn, if you're seeing behaviors change at all.

You can see through the third quarter our depletions continued the trend line that we have seen all year. I think the big wild card that is speculative now is what's happened in the last four or five weeks as kind of the tonality about a recession has changed. We have seen some softening in IRI trends but it's just a matter of a few weeks so it's still too early to tell.

Okay. And any updates on the sort of mixed dynamics between on and off premise, or any further color on that front or it's really more the same?

Yes, hi, Lindsay, it's Martin. I think we have been relatively surprised how our on-premise business appears to have held up relative to the reported numbers that are being reported by the, the restaurant chains so I'd say it was more of the same.

Okay. And then I was just hoping to get a little bit of clarification on some of the noisy items that are flowing through your P&L this quarter. Outside of the recall costs and the accrual for the transition to the Pennsylvania Brewery that you mentioned, are there any other one-time startup costs embedded in the quarter?

Lindsay, this is Martin again. There are regular startup costs of the Pennsylvania Brewery by which I would mean to say that we are obviously ramping up production there while carrying a full overhead and full cost of the brewery and we are also hosting Diageo production, which has its own costs and complexities associated with it. We are also still executing some capital projects that are designed to reduce operating costs and those are not yet complete.

Is there any way to get a bit more color on what of the costs that you're incurring this year are unlikely to be repeated next year?

I think at this point in time we are uncomfortable providing that information as we are still learning the full costs of the brewery and the exact timing of the capital projects is a little uncertain. We have attempted to address your question by providing guidance as to our cost climate for 2009.

Okay. All right. Thanks very much.

Thank you. Your next question comes from the line of James Watson with HSBC.

Good afternoon, guys. My first question for you is, really is also to the fees from the third-party Brewers, and I was just wondering what the rationale was for moving the volumes over to the, new Pennsylvania Brewery so early. Is it just to offset sort of the fixed costs of the big brewery and also, would you see more of these in the fourth quarter of this year?

Hi, it's Martin again. We moved volume into the Pennsylvania Brewery as the line speeds ramped up and our brewing capabilities ramped up, because in our estimation there were some cost savings of doing so relative to leaving our brewing at these other breweries.

Our interpretation of the accounting requirements is that having an expectation that we could incur a shortfall fee for not meeting minimum volumes for full 2008, that those needed to be recognized from an accounting perspective when there was a significant likelihood of them happening this year. So I think the charge that we have taken represents our best estimate of what those shortfall fees should be. Looking forward to 2009, we have a variety of contracts with these breweries of which some require shortfall fees and our guess as to shortfall fees in 2009 is they will be less than what we have booked in the third quarter for 2008.

Great. Thank you. One more question on the -- on cogs, just you need to eliminate percent increase next year and you said that was mainly coming from the glass contract and, the depreciation of the new overhead costs. I was wondering about the other two big costs for you, the agricultural costs and freight costs and if you've seen any improvement sequentially as compared to the last call on those costs and how that's changing your outlook.

Our sort of planning process for 2009 is still preliminary and is based on some work done over the last six, eight weeks and we took into account in that planning process, known information on hops, barley and energy utilities, generally. Addressing each individually, we have contracted out hop contracts with European -- or mainly European Farmers for several years locking in pricing and such. We are exposed to some foreign exchange movements but obviously the dollar has been somewhat stronger the last three months than the historic trend.

The 2008 crop in Europe looks good quality. Jim was over there I think a couple of times the last three months in selection and we think the -- therefore the cost pressures on the hops side at least for 2009 appear very manageable. On the barley front, that is sort of dictated by market price for corn and for barley and historically we have made arrangements to buy barley for the next year in the August, September, October time frame. We have made those arrangements and therefore our projection on cost of goods includes our estimate of what is happening there.

I think if you were to look at the published report there was some softening on the commodity side based on crops and demand. With regards to freight, we report freight in -- the majority of our freight we report in the SG&A line. There is some freight in the cost of goods line but the majority is in the SG&A line and our freight costs are driven by brewery locations and as we look into next year, we will not benefit from the arrangement with Miller where Miller was providing us with West Coast freight efficiencies as if the product was shipped from a West Coast brewery. So we do expect some freight increases related to that but we also believe that concentrating on brewing and packaging into company owned breweries, particularly one close to the northeast, will have some freight benefit to us.

As it relates to the sort of movement of freight costs, we are exposed to the price of diesel primarily, facing fuel surcharges and certainly, looking at the gas pump this morning, it looks like that may be easing a little, although we are obviously in a period of relatively high volatility on all commodities and it's tough for us to commit as to exactly what these numbers are going to look like next year and we have historically not hedged fuel or energy to any significant degree.

Great. And just to clarify, you don't hedge the currency exposure either, right?

We have not historically, no.

Okay. Great. Thank you very much.

Thank you. Your next question comes from the line of Bryan Spillane with Banc of America Securities.

Good afternoon, guys.

Hey, Brian.

A couple of questions. I guess first depreciation expense in the quarter, I know the cash flow statement is $8.2 million versus $4.7 million for the nine months year on year. What was the expense in the quarter?

Brian, why don't you ask your second question --

I'll ask the next one while you guys are looking at that. And then on the accruals for the minimum requirements for the contract Brewers, I'm assuming that the contract Brewers now are or in the quarter would have been Miller, High Falls and am I missing? Is there something else that's in that?

Brian, we currently have in the quarter we had contract relationships with High Falls, Miller Brewing Company and City Brewing for both their Lacrosse, Wisconsin location and also their Latrobe location.

Okay. And then accrual you have made is assuming short falls with all of your contract Brewers and I guess more specifically is Miller part of the equation there?

I think our practice has been not to comment on actual contract details, but the dollar amount that we have taken as an accounting charge is what we estimate all the shortfall fees will be for 2008 based on current expectations for volume and production location and therefore would include any shortfall fees due Miller, if any.

Okay. And then that's -- what I was getting at is when we look at next year, the Miller piece of the equation at least wouldn't be there and the question is whether or not how you managed the other contract brewing relationships, right?

We actually have a new agreement with Miller that replaces the old agreement.

Okay.

I don't provide that information to indicate positively or negatively whether there are shortfall fees relating to that agreement but just to clarify and make sure you understood that we do have a Miller contract relationship for 2009 that's available to us.

Okay.

And then I think what we have said is we expect the shortfall fees that we would owe or need to expense in 2009 to be significantly lower than the 2008 level.

Okay. And then on the accrual you've booked, I'm assuming that's the accrual is equal to the cash expense, you've booked whatever the actual -- what you expect the actual fees to be? Like there shouldn't be a difference between the accrued expense and the cash expectation?

Brian, I'm not an accountant but that is my understanding of the intent and the only thing that might change is if our estimate of volumes or production locations, ultimately ends up being different than what we had estimated when we made the provision.

Okay. And then in the press release there's the description of 2009 total costs to be up 8% to 11%. I just wanted to clarify. Is that just cost of goods sold or is that your total costs?

That is just cost of goods sold.

Okay. So it wouldn't include your fuel costs which is booked below cost of goods sold or yes, your fuel costs?

That would not include any increase or decrease in freight costs as it relates to outbound freight. We record inbound freight which is raw materials freight and inter-brewery warehouse freight in our cost of goods line.

And then on the Diageo production volume and for give me if you've already disclosed it, but I want to make sure I'm clear on this. The impact it has on your gross and your operating profit margins, does that Volume have some sort of fixed margin percentage attached to it? Is it relatively static and is it more or less than your corporate average?

As part of the purchase of the brewery we agreed to provide Diageo with production access to varying capacities over the next two years and that pricing, it is fair to say is relatively attractive to Diageo but we believe is above our variable costs.

Okay.

But to claim that there is profit in that business would probably be a big leap of faith.

Okay. Okay. And then in terms of inventories, it looks like they are running a little bit higher year to date than they were a year ago. Is there anything we should think about there in terms of inventories?

Yes, Brian, it's Bill.

Hey, Bill.

We had just happened to be at the end of the quarter, our finished goods were slightly higher and then work in process relative to brewing at the Pennsylvania Brewery.

Okay.

Brian, it's Martin.

Uh-huh.

I think if we transition volume into our own breweries, you will see some inventory increase to reflect that piece of the beer and packaging that we did not own under our prior relationships.

Okay. Okay. That makes sense. Yes, your inventory would be higher because you're brewing more of the beer yourself essentially, right?

That is correct.

Okay. And then in terms of the amount of production you're brewing, it sounds like from our perspective that that the startup in Pennsylvania has gone at least in line if not maybe a little better in terms of the amount of volume you're producing there.

So relative to the time line. Are you -- has this kind of happened better than you expected product quality, if you could talk a bit about just how that's worked, what's the -- how much waste or what the efficiencies are at this point, anything that we can just get a sense for how this has gone relative to the expectations you guys had set internally when you started this project.

Yes. Well, I think we are relatively delighted with how the transition has gone. I think specifically in my talking points I talked about how we have really had no disruption that we are aware of either to our business or to Diageo's business. We have had excellent transfer of employee base with a safe, working environment with no change in accidents rates or stuff like that.

From a beer quality perspective, we are delighted with the beer. It meets our expectations and I'll be enjoying one tonight.

From a capital perspective, it's a big project for us and we've had, some positive surprises and some negative surprises, but net-net we are on plan and on budget. I think it's fair to say that we part hats on the capital side are not totally on time but we certainly did what we needed to to transition brewing in and until we complete all of those capital projects, we won't have a fair picture of the operating costs of the breweries and implicit in your question is about efficiencies and as we think about efficiencies, there's material yield efficiencies that are affected by capital projects in a brewery of this age.

Also, line efficiencies and run speeds and those are also affected by capital projects and I don't think as we indicated we have seen the ending efficiency points on either of those items yet and indeed probably won't until the middle of 2009. So we are working hard having moved through the startup phase on addressing those efficiencies and to complete the capital projects that will stop some costs that we are experiencing right now, that some of those costs will go away when those capital projects are completed.

And so all in all, I think we are very happy. If we could have written this script a year ago, I think we would have been very happy. We set very high performance standards for ourselves and we would certainly like to be operating at higher efficiencies with lower costs, but we see that in our future.

So I'm assuming just by those comments that there is nothing restraining you from wanting to sell as aggressively as possible next year? You feel like you'll be able to produce as much beer as you need and there's no real restraints where that might not have been the case as you went into the selling season in 2008 because you had a pretty major shift in production happening?

Well, I think that we have always structured our business to attempt to be not capacity constrained by combining brewery ownership and contract and certainly in 2008 we had excess capacity available to us under contract if we would have wanted it and while we anticipate next year that most of our brewing and packaging will be in breweries we control, we anticipate maintaining contract relationships to allow us to meet our drinkers' needs to the extent that they want us to.

Okay. And then just, Bill, finally, if you have the depreciation number.

Yes. I don't actually have the quarter depreciation in front of me because I'm always looking pretty much at what the full year depreciation is going to be, but since last year we have increased our depreciation amortization by three, roughly $3.5 million, Bryan.

Okay.

Most of which would have been relative to bringing on the Pennsylvania Brewery and also the depreciation of incremental tags that we purchased.

I'm just trying to get a run rate on whether or not the current depreciation amortization, because now you've got the brewery started and you've got the kegs, so there shouldn't be another significant step-up sequentially from where we are kind of running now on a quarter to quarter basis; is that right?

Well, I guess I would say as we indicated in the press release, we have about $31 million worth of capital projects currently employed. We have a target this year of $45 million to $55 million and our target next year is somewhere in the range of $25 million to $45 million, so as those assets are employed and put in service, there will be associated depreciation with those also.

All right. Great. Listen, thanks for entertaining the questions. I can go have a beer now too.

Enjoy.

All right.

Thank you. Your next question comes from the line of Andrew Kieley with Deutsche Bank

Can you remind us with the Diageo rolls off, I think it was second quarter next year but is that full stop, it ends there or will that be expended .

I'm not totally sure we publicly disclosed that and the agreement with Diageo is covered by confidentiality agreements. What we have, I think indicated, is we anticipate that the volume with Diageo will decline over time and we will transfer volume to sort of compensate. So certainly, in the second half of next year we expect the Diageo volume to be significantly lower than it was in the second half of this year.

Okay. Thanks and then just following up on Brian's question about the 8% to 11% the cost of goods guidance, that includes depreciation?

Yes, it does.

Okay. And can you talk at all about what that expectation embeds in terms of savings from the Pennsylvania plant? I mean it sounds like you're really only expecting that to help in the second half of next year.

I think it's fair to say that we expect those savings to, the efficiencies at the brewery to come online sort of and benefit the second half more than the first half, I think as we look at our decision to abide the brewery, in many ways it was as much about security of supply and controlling our own destiny as economics and until we have the brewery up and running to the efficiencies that we targeted, we are not that comfortable talking about what the financial benefits will be, other than to say that the decisions were as much security of supply as they were financial.

Okay. Have you said how much you're brewing there now, I mean, in terms of percent of production?

We have not disclosed that and I think would prefer not to in the likes of our contract relationships and how that information affects our contract partners.

Okay. Another question just on the on-premise, off-premise shift. If you could give us any color at all it would be appreciated,what kind of maybe gross profit differential there is, if consumption shifts from off-premise to on-premise. Can you talk at all about the margin differential on a one to one basis if we shift from on promise to off premise?

Yes. The margins are in the same ballpark, depending on do we have to buy a whole bunch of new kegs or are we using fully depreciated kegs so some of it depends on growth, but roughly margin percentages between on-premise and off are comparable. The on-premise is principally draft which has a lower selling price per case equivalent than off-premise which is principally bottles.

Okay. So lower selling price but --

But roughly comparable margins.

And final thing I had was if you could repeat what you said about the tax rate guidance and what, maybe what the underlying rate was that you're using for this quarter.

The underlying rate, let's see. The rate that we are using for the quarter is in excess of 100%. I think it's 123% or something in that neighborhood, but the point is, what's happening to the rate. What's happening to the rate is, for the year and I think it's important to talk about for the year, is we've had significant decrease in income primarily related to the recall and we had no decrease in permanent non-deductible items like meal and entertainment expenses, which we have a reasonable amount of as a company that you cannot deduct by the IRS rules.

And then we also have some other deductions relative to manufacturing that you can take those deductions, provided you have certain levels of income, and since most of the income has gone away, all the deductions have gone away and that's created a situation where we are looking at roughly 51% rate for the year.

Okay. Thank you very much.

Thank you. (OPERATOR INSTRUCTIONS). There Is no more questions at this time.

Okay. Just before we conclude, I've been alerted by a member of our office that people listening to this call on the web maybe did not pick up the first five minutes of the call and we have been advised by the web hosting authority that they will have the full call up in approximately an hour. So we apologize for that technical difficulty and have enjoyed everyone's presence on the call and look forward to talking to you when we have our full-year results. Cheers.

Thank you.

Thank you.

Thank you for joining today's conference call.